There are several ways to analyze the forex markets, and no one style is considered the wholly grail. Most traders focus on technical and fundamental analysis, as the combination of historical price action and economic data, will help you evaluate the future direction of an exchange rate. While, it’s important to understand the driving force behind the macro changes in the economic landscape, if you are attempting to generate revenue by capturing short term movements in the forex markets, understanding different technical analysis methods will be a key to your long-term success.
Technical Analysis
One of the most effective way to capture gains in the forex market is to follow price trends. Trend following strategies are geared toward generating robust gains when a currency pair starts to move. Markets unfortunately are usually rangebound, so when they begin to trend, it’s important to recognize the change in this dynamic and place a trade that will benefit from a long-term move.
Moving Average Crossover Strategy
One of the best ways to evaluate a trend is to use a trend following strategy. One of the most popular is a moving average crossover strategy. Moving averages are the average of a specific number of trading periods. To learn more about moving averages, take a look at iFOREX technical analysis. The periods you use can range from intra-day, such as hourly, to daily, weekly or even monthly. A crossover strategy is one were a short term moving average, crosses either above or below a longer term moving average, which describes the direction of a trend.
For example, the chart of the EUR/USD shows the exchange rate along with the 10-day simple moving average and the 40-day simple moving average. When the 10-day moving average crosses below the 40-day moving average, a short-term down trend is in place. Conversely, when the 10-day moving average crosses above the 40-day moving average, a short term up trend is in place. When the EUR/USD trends, this strategy works very well, but when the exchange rate consolidates, this strategy produces false signals that will generate choppy conditions.
Simple and Exponential Moving Averages
You can alter the moving averages, to smooth the trend. For example, you could use a 20-day simple moving average and the 50-day simple moving average. You also could attempt to speed up the signals by using an exponential moving average. This type of moving average puts more weight on current prices as opposed to having an equal weigh moving average calculation. Regardless of how you alter your strategy, you will likely see that the strategy works very well when the market actually trends, and performs poorly when the exchange rate you are trading consolidates.